The CARES Act: Code Section 163(j)

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act) was signed into law as the third COVID-19-related stimulus package. The newest package consists of approximately $2.2 trillion of financial relief to assist with supporting businesses and individuals that have been negatively impacted by the economic decline.

This article discusses the modification to the business interest expense limitation enacted under the Tax Cuts and Jobs Act (TCJA) in 2017. The TCJA modified section 163(j) to limit certain entities business interest deduction.

The amended Code Section 163(j) impacted taxpayer's with average gross receipts of $25,000,000 or more and generally limited the business interest expense deduction to the sum of the business interest income plus 30% of the taxpayer's adjusted taxable income. To provide additional financial relief to taxpayers, the CARES Act temporarily increases this limitation to 50% of adjusted taxable income for the 2019 and 2020 taxable years.

Adjusted taxable income is calculated as follows:

*Beginning in taxable year 2022, adjustments for depreciation/amortization/depletion and for the gain from the sale or disposition of property will no longer be included in the calculation of Adjusted Taxable Income.

In addition to the increased 50% of adjusted taxable income, taxpayers will have the option to elect to use the 2019 adjusted taxable income for the 2020 calculation. This is included as attempt to provide additional relief assuming that the 2020 adjusted taxable income will be reduced due to the economic hardship businesses are facing.

The CARES Act includes a separate temporary provision for the business interest expense calculations for partnerships. Under 163(j), partnerships passthrough the interest expense limitation to its partners. Any unused business interest expense is carried forward and can only be used to offset business interest income and adjusted taxable income from the partnership that originated the deduction. With the temporary adjustment under the CARES Act, the 2019 business interest expense is first calculated based on the sum of the business interest income plus 30% of adjusted taxable income. Then, the partner is allowed to deduct 50% of the limitation in 2020 without being subject to the limitation. The remaining 50% is carried forward and included in the limitation calculation under Code Section 163(j).

It is important to note that taxpayers can elect out of each of the updated provisions included in the CARES Act as it relates to the business interest expense limitation adjustments under 163(j). It may be beneficial for taxpayers to elect out of these temporary adjustments when taking into consideration the potential NOL generated due to the increased deduction which is subject to limitations if carried forward to future years. However, once the election is made, it can only be revoked by the Secretary's approval.

There are several potential tax planning opportunities included in this provision, but taxpayers should review the information carefully and consider the negative impacts to the increased deductions. To discuss the options of the adjusted 163(j) and any other provisions under the CARES Act, please consult your HLB Gross Collins adviser.